The Financial Modernization Legislation: An Assessment

ON THE GRAMM-LEACH-BLILEY ACT:

Why my lukewarm enthusiasm for the Act? There are several reasons. First,
it was only of help in dealing with the barriers between banking and insurance.
The barriers between investment banking and commercial banking had long
since been largely obliterated Glass-Steagall was essentially a
nullity by 1999. Second, there are some bothersome demodernization provisions
in the Act, such as prohibiting the creation of new unitary thrift holding
companies. This was a setback to attaining a more competitive financial
system, a setback I hope will be rectified soon.

ON BANKING AND COMMERCE:

Admittedly, there are some who believe, with almost theological fervor,
that the separation of banking and commerce is deeply rooted in U. S.
banking history and, indeed, is a part of natural law. As a matter of
historical fact they are simply wrong. Not so long ago, the General Counsel
of the Treasury Department summarized the historical evidence and record
succinctly and accurately: "There has never been a national policy of
separating banking and commerce."

On Nov. 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley
(GLB) Act, an attempt at financial modernization almost two decades
in the making. As the draft legislation gathered momentum, particularly
in its later years, it became what Washington describes as "Christmas
tree" legislation, which means that a variety of legislative "bulbs"
were hung on it as it went by. As a result, evaluating the new
law is difficult because so many of the provisions, however important
or unimportant, and however worthy or unworthy, have little or
nothing to do with financial modernization as that term is usually
understood.

It is important to note that the GLB Act is not a deregulation
measure. Indeed, if the Act were to be judged on its success in
achieving significant deregulation of financial institutions it
would have to be counted as an abysmal failure. If anything, the
federal regulatory structure for banks and other financial institutions
was left in worse shape than it already was. The Act does embrace
such important matters as the role to be played in the future
by the Community Reinvestment Act, as well as consumer privacy
issues. However, these were not central to the legislation; in
fact, privacy issues only arose rather late in the game.

Probably the most reasonable and fairest way of judging the
new Act is to focus on the objectives of its principal architects.
Financial modernization in their eyes meant that it was necessary
to recognize and deal with the fact that, because of technological
change and market forces, the old lines separating commercial
banking, investment banking and insurance companies were no longer
sustainable. The principal authors of the legislation sought the
reduction or elimination of government-constructed barriers to
affiliations among institutions in the three industries. Accordingly,
two questions can be posed. First, did the Act achieve the objectives
of its champions? And second, what still remains to be done? On
these terms, the Act, in my opinion, must be judged to be only
a modest success.

Why my lukewarm enthusiasm for the Act? There are several reasons.
First, it was only of help in dealing with the barriers between
banking and insurance. The barriers between investment banking
and commercial banking had long since been largely obliteratedGlass-Steagall
was essentially a nullity by 1999although the Act did some
useful mopping up. Second, there are some bothersome demodernization
provisions in the Act, such as prohibiting the creation of new
unitary thrift holding companies. This was a setback to attaining
a more competitive financial system, a setback that I hope will
be rectified soon. Third, on balanceand not without taking
a few steps backwardthe Act made a useful contribution to
eliminating the barriers between insurance and banking, but the
erosion of such barriers had been under way for some time prior
to the Act. It is interesting that even the example cited most
often as typical of the problem caused by existing lawthe
need for Citigroup to divest itself of insurance operations unless
the new legislation was enactedhad been dismissed almost
casually by the Wall Street Journal. That journal
identified several options already available to Citigroup under
existing law.1
To be sure, passage of the Act was probably a more desirable option,
but not the only option, and I suspect that this was also the
case in many other situations. The GLB Act's contribution was
not so much the granting of permission as it was simply that of
getting government out of the way.

Finally, the new Act will not be of any lasting importance to
financial modernization unless it is soon accompanied by other
legislation. If financial modernization is truly the objective,
then the GLB Act is, at best, "the end of the beginning." Probably
most urgently required are regulatory reform, deposit insurance
reform and elimination of the near-theological belief that a line
must be drawn between banking and commerce. There is neither time
nor space for a full discussion of any of these subjects, let
alone all three (to say nothing of still others that could be
mentioned, such as universal banking). Only a few brief comments
on each of the first three can be made here.

Even while the financial modernization legislation was being
debated, The Economist characterized the U.S. regulatory
system as "hopelessly fragmented and costly" (Oct. 30, 1999).
It is now even more so. The almost unbelievable complexity of
the U.S. bank regulatory structure is due largely, but not entirely,
to the decision made in the Bank Holding Company Act Amendments
of 1970 to leave the oversight of holding companies solely with
the Federal Reserve. This decision meant that, effectively, bank
holding company regulation was separated from bank regulation,
placing each on separate tracks and thereby creating overlap,
duplication and conflicts of purpose (if not of interest). Not
only has the GLB Act exacerbated the problem by creating still
another set of overlaps with divided authoritythe new "financial
subsidiary" arrangementbut it has also extended the system
to embrace important aspects of investment banking and insurance.
It is truly a bizarre arrangement found, I believe, only in the
United States. That it can work at all is because of the practical
accommodations made by professional career administrators.

There is no point to extending this discussion unduly, but I
cannot resist an item recently called to my attention: The Board
of Governors of the Federal Reserve, under the GLB Act (Sec. 205),
may take exception to certain proposed regulations by the Securities
Exchange Commission and request that a regulation be set aside.
Any proceeding to challenge the rule would be handled by the U.S.
Court of Appeals for the District of Columbia. Admittedly, it
has been many years since I studied Administrative Law, but I
do not recall a provision enabling one named federal agency to
bring an action against another named federal agency. It is, at
the very least, highly unusual. It is also indicative of the regulatory
morass we have created in this country.

In my own writings, I have called attention repeatedly to the
fact that calls for modernization of financial law are occurring
in other countries as well. In fact, there is under way a worldwide
movement to reform bank regulatory structures in order to cope
with new market pressures and rapid technological change, something
the United States has yet to address. The result in the rest of
the world has been the creation of new regulatory structures and,
in almost all cases, the separation of the central bank from the
supervision and regulation of financial institutions (largely
because of fears of conflict of interest problems and a loss of
political independence by the central bank). Sweeping changes
have recently been made, or are under consideration, in the United
Kingdom, Japan, Korea, Australia, Canada, Luxembourg, Ireland,
Israel and South Africa, according to an official of the Financial
Services Authority (FSA), the new British agency created to handle
this matter.2
Even earlier, Belgium, Canada and Switzerland had separated their
central banks from bank supervision and regulation. When the chairman
of the FSA recently reviewed the current situation he could only
add that: "It is fair to say that the U.S. system is not now typical
of international practice."3
Strangest of all is the fact that the proponents of the GLB Act,
and the Congress as a whole, have resolutely ignored, at least
thus far, what is happening in the rest of the world.

Several years ago in an article written for Banking Policy
Report (Jan. 20, 1997), I said that "deposit insurance,
in its present form, may be the last and most formidable roadblock
to the modernization of banking." I had in mind, as just one example,
the fact that we have today, because of the Federal Deposit Insurance
Corp. Improvement Act, a complex system of capital regulation,
the stated purpose of which is to protect the federal government
against loss when fulfilling its deposit insurance commitment.
In other words, the present system of deposit insurance goes to
the very core of laws and regulations affecting banking.

Readers are familiar, I am sure, with the long-running debate
over the so-called "safety net" subsidy allegedly enjoyed by insured
depository institutions. The safety net subsidy refers essentially
to deposit insurance, and it is that subsidy, assuming it exists
or is relevant, that accounts for the new life given to the bank
holding company structure (geographic restrictions on banking
having disappeared several years ago).

The case for deposit insurance reform has many facets. The literature
dealing with the need for reform is impressive, as is the stature
of many of the proponents who, incidentally, include important
officials within the Federal Reserve System. It is difficult for
me to believe that there can be lasting and meaningful financial
modernization without a thorough examination of the proposals
for deposit insurance reform that are presently on the table.

The continued separation of banking and commerce is likely to
be reexamined again. Sen. Gramm, chairman of the Senate Banking
Committee, made this point rather forcefully when agreement had
been reached on the new Act: "There will be another banking bill
within ten years and it will deal with commerce. ... This bill
is a pause, and it is only a pause, and it is not going to last
very long."4

Admittedly, there are some who believe, with almost theological
fervor, that the separation of banking and commerce is deeply
rooted in U.S. banking history and, indeed, is a part of natural
law. As a matter of historical fact they are simply wrong. Not
so long ago, the General Counsel of the Treasury Department summarized
the historical evidence and record succinctly and accurately:
"There has never been a national policy of separating banking
and commerce."5

More is involved, however, than a dispute among historians.
Banking is a live, vibrant, ever-changing business. Efforts to
constrain it are either doomed to failure or, more likely, doomed
to destroy the business itself, to force it into other channels.
This has been recognized clearly whenever there have been attempts
to devise rigid rules to define what is, and what is not, the
banking business.

Never has this been more persuasively argued than by a New York
court about a century and a half ago. In 1857, the New York Court
of Appeals was called upon to interpret a section of New York
law that included among banking powers "such incidental powers
as may be necessary to carry out the business of banking," a section
later borrowed by the federal Congress and placed in what became
the National Bank Act. The Court's words still resonate:

The implied powers [of a bank] exist by virtue of the grant
[to do the business of banking], and are not enumerated and defined;
because no human sagacity can foresee what implied powers may
in the progress of time, the discovery and perfection of better
methods of doing business, and the ever varying attitude of human
relations, be required to give effect to the express powers. They
are, therefore, left to implication.6

In my view, no more serious error could be made in modernizing
financial law than to attempt to confine the powers of banks to
their 1999 boundaries.

Note: This article draws heavily upon a more comprehensive analysis
of the GLB Act prepared by the author, and published as Vol. 1999-9
in The Golembe Reports under the title "Financial Modernization
Legislation: The End of the Beginning," Dec. 1, 1999.

Carter Golembe is president of CHG
Consulting in Delray Beach, Fla. From 1966 to 1989, he managed Golembe
Associates, a
Washington-based banking consulting firm. Golembe is the author of many
articles, columns and analyses and is the principal author of the Golembe
Reports, a long-running review of major policy issues relating to banking.
Golembe began his banking career nearly 50 years ago with the Federal
Deposit Insurance Corp. and has worked for Congress, major banking organizations
and their trade groups.

For Carter Golembe's thoughts on other financial services issues, see
his interview in The Region,
June 1998.